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How a High-Yield ETF Beat Its Benchmark

The lower quality bonds could sag in a downturn. But Gramatovich argues that his holdings could survive recessions and continue making interest payments. He says that the ratings agencies often give small bonds lower grades than they deserve.

A favorite holding is an issue from EnergySolutions (ES), which disposes of radioactive wastes for government and commercial customers. The bonds yield more than 10% and trade in the mid $90s. The bonds sank recently after the company reported disappointing earnings. But Gramatovich argues that the company will rebound because it provides a vital service.

Since the beginning of 2011, assets in high-yield ETFs have grown from $13 billion to more than $28 billion. All that cash has helped to push up bond prices. Now many analysts worry that high-yield bonds have become too expensive.

Gramatovich agrees that certain issues are rich. He says that some of the double-B-rated bonds favored by the index funds only yield 4%. That is too low of a payout to compensate for the risk of default. But he argues that his fund's unloved issues are still bargains. At a time when five-year Treasuries yield 0.62%, bonds that can yield 8% are worth holding.

Gramatovich says that the current environment is ideal for his bonds. With the economy growing slowly, few companies are defaulting. At the same time, the outlook is so uncertain that corporate executives are hording cash and avoiding risky investments. That provides security for bond holders.

"We don't need a great economy," says Gramatovich. "We like exactly the environment that we have."

At the time of publication, Luxenberg had no positions in securities mentioned.

Stan Luxenberg is a freelance writer specializing in mutual funds and investing. He was executive editor of Individual Investor magazine.
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